Failure to Contribute: An Estimate of the Consequences of Non- and Underpayment of Self-Employment Taxes by Independent Contractors and On-Demand Workers on Social Security

WP#2019-1

Abstract

While existing academic and government research has focused on the size, growth trajectory, and labor and tax law implications of independent contractors, freelancers, and workers selling goods and services online and through app-based platforms (the “on-demand” economy), less work has been devoted to quantifying the Social Security implications for the on-demand economy and its workers. Although it is known that self-employed workers have tax compliance and reporting issues, the existing reporting rules applicable to most workers earning income in the on-demand economy substantially increase the likelihood that these taxpayers are failing to contribute to Social Security and Medicare through payment of the self-employment tax (SE tax). As such, this paper sheds light on the Social Security implications of current federal tax rules for independent contractors generally and, in particular, workers earning income through occupations occurring in the on-demand economy by estimating the population and earnings of these workers using the U.S. Census Bureau’s redesigned Survey of Income and Program Participation (SIPP).

By analyzing 2014 SIPP data, we identify a population of self-employed, non-employer respondents working outside of a traditional employment relationship (“independent contractors”), as well as individuals working in occupations in the on-demand economy (“on-demand workers”). SIPP data have the potential to capture workers who earn income using on-demand platforms to connect with customers and process payments (“on-platform work”), as well as workers who earn income in occupations occurring in the on-demand economy who do not use on-demand platforms (“off-platform work”).

Additionally, with SIPP data, we are able to estimate the income that independent contractors and on-demand workers earned in these employment relationships in 2014. Using Internal Revenue Service (IRS) data on the tax gap, U.S. Treasury Department audit data on underpayment of the SE tax, and survey data on tax compliance by on-demand economy workers and the self-employed, we are able to create an estimate of how much SE tax should have been paid on this income but likely was not. To provide context for our findings, we applied the methodology we developed to estimate the likely underpayment of the SE tax to data published in 2018 by the U.S. Bureau of Labor Statistics on the number of independent contractors and on-platform workers in 2017. In addition, using SIPP, we were able to provide supplemental demographic data on independent contractors and the on-demand platform workforce.

The paper found that:

Approximately 7.1 million individuals were independent contractors, and 3.1 million individuals were on-demand workers in 2014.

Using SIPP data, we estimated that independent contractors earned approximately $204.1 billion in income in 2014, and on-demand workers earned approximately $36.0 billion in 2014.

Based on our review of SIPP data and existing measures of misreported self-employment income, we estimate at least 3.1 million independent contractors underreported self-employment income in 2014. This underreporting would result in approximately $4.8 billion in SE tax that should have been paid, with approximately $3.9 billion constituting non-payment of Social Security contributions.

Using SIPP, as well as existing research on tax compliance and information reporting for on-demand workers and the self-employed, we estimate that $2.5 billion in SE tax was not reported or underreported by on-demand workers in 2014. This translates to $2.0 billion that was not paid into Social Security.

Using SIPP, we found that independent contractors were most often Baby Boomers (i.e., ages 55 and over), were more likely to be women than men, and were more often white than any other race or ethnicity. On-demand workers were more often Generation X (i.e., ages 34-54), more likely to be women than men, and were most frequently white, rather than any other race or ethnicity.

Our estimates of the likely additional SE tax owed by independent contractors generally, and more specifically by workers in the on-demand economy, could undermine efforts to fund Social Security and translate to lower Social Security benefits for these workers upon retirement.

Since 2016, Congress, the Treasury, and the IRS have been aware of tax compliance challenges triggered by the current information reporting regime with respect to on-demand platform workers. In addition, since at least 2007, the Treasury and IRS have been aware of the widespread underreporting of self-employment taxes and its impact on the tax gap. With the advent of the on-demand economy and its workforce, these problems have grown exponentially, notwithstanding efforts to increase tax compliance through additional information reporting.

The policy implications of the finding are:

Policymakers could consider proposals targeted to increase tax compliance and Social Security contributions for independent contractors generally, and for the on-demand economy workforce in particular.

Congress could take steps to modernize information reporting, update quarterly estimated payment requirements, and require distribution of tax guidance to help combat underreporting of self-employment income and support the solvency of Social Security.